Traders heartened by materials promise

Europe hasn’t gone away as a source of angst for traders, but it wasn’t uppermost this week. In fact, many steered clear of trading the Aussie dollar against the euro and other currencies and instead focused on the action in shares.

“We got off to a good start this year. People are focusing on positive US economic data, which for the first time is starting to trump negative news out of Europe. We are starting to see European matters on the back burner to some degree," says Cameron Peacock, analyst at CFD provider IG Markets.

As a result, he says, cyclical shares did well, providing buying opportunities for traders in the materials sector, notably BHP, Rio, and Fortescue. These stocks showed significant share price falls in 2011 – Rio Tinto plummeted 29 per cent, for example – but are now outperforming.

QBE
’s precipitous drop from $13 at Wednesday’s close to a low of $9.88 following a poor profit forecast was a trap for traders with long positions in the stock, but a quick earner for those nimble enough to sell on the way down and then avoid the next pitfall – a quick bounce back to $11.35 at the close on Thursday.

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“You never want to be caught on the wrong end of a move; some traders would have been closed out long and some saw the opportunity to go short," Peacock says.

In the currency markets, “Liquidity measures that may be introduced in China created a positive aura for the Australian dollar as well as mining stocks," he says.

Peacock says the Australian dollar is benefiting from higher commodity prices and an improving US economy, which means improved metal prices.

“The Australian dollar has held up well, considering the US dollar is at one-year highs of 81 on the dollar index. We are seeing the euro being sold off against the US dollar. When the euro fell last year the Aussie dollar fell too, but now it has broken the correlation."

Some traders have a target for the euro of $US1.20 compared to its level on Friday of $US1.28. The reasoning is that everything the Europeans are doing to deal with the debt crisis is geared toward a lower value for the euro.

In commodities, “gold underperformed late last year but money is now moving out of the euro and into gold," Peacock says. From under $US1550 at the start of the year, gold has climbed to $US1640, a rise of almost $US100 an ounce.

“Oil is interesting; some are surprised that it’s as high at $US99.30 a barrel, but the US dollar has been rising over the course of this year and the oil price is off. The energy sector is off in US, so that market is being dragged down by some weakness there."

He points out there is a wide range of opinions about which way the oil price will go, but it appears to be in a range between $US95 and $US105 at present. There is probably a fear premium of about $10 built into the price because of Middle East tension, he feels.

Kara Ordway, currency analyst at CFD provider City Index, says that since the beginning of 2012 trading has been focused on the euro, which is at an 11-year low against the yen, and an all-time low against the Australian dollar. It’s not doing so well against the US dollar, either.

“This is a precedent for what traders are thinking about the euro going into this year," Ordway says. “It’s a very different dynamic in the FX market that’s now being driven by the euro. A currency seeing lows like that is not going to do well for the rest of year, especially against Aussie dollar."

The euro’s recent bounce was the result of a large number of sold positions having to be covered on any buoyancy in its level against the US dollar. An upward blip tends to tip the sellers out – their stop-loss orders get them out in case the rise continues. This short covering – buying to exit sold positions – tends to exaggerate the bounce.

“When we see news that is not dire the market will move up and traders will cover shorts which will push it higher – not necessarily from anything positive out of Europe. Traders are not building up new positions," Ordway says.

“Europe is nowhere near out of the woods yet. Despite holding rates at 1 per cent they may be looking to cut rates later on in 2012 – they may have just delayed it rather than ruling it out.

“Another consideration for traders in 2012 is the credit Asia has with Europe and what affect repatriation of funds back to Europe will have on Asia.

“Countries like China … won’t hurt as much but Malaysia, Indonesia and Singapore have exposure to that, which may start hurting Asian growth and potentially the Australian dollar."

She says the Australian dollar seems overbought compared to other commodity currencies like the Canadian dollar, and expects it to form a base level around parity with the US dollar rather than its current level of $US1.03.

“That’s what clients are doing – going short the euro and short the Aussie dollar,“ Ordway says. “But they are nervous about trading the Australian dollar against the euro. We haven’t seen much activity in that pair."

She foresees that as traders become aware of the all-time lows the euro has made against the Australian dollar, trading will pick up. “But there is very much uncertainty about the euro and the Aussie is a volatile currency."

In shares, Ordway says, “we saw a lot of selling in QBE on Thursday before the bounce. Traders bought a lot of it back today [Friday]. But it wasn’t highly active. Clients were short Rio and short CBA, long Macquarie and long Woodside. Most are running a balanced book [with no long or short bias] because they saw so much volatility in 2011."

In the options market, she says, there was a large number of call options sold over the S&P/ASX 200 index. The calls were at-the-money with expiry in the current month, and sellers benefit if the market remains steady or falls slightly in the short term. At-the-money options have an exercise price close to the current index level.